Kewaunee Scientific Corporation: Form 10-Q Summary
Business Context and Reporting Period
This quarterly report covers the three and nine months ended January 31, 2018, Kewaunee’s fiscal third quarter and first nine months of fiscal 2018. The company designs, manufactures, and installs laboratory, scientific, healthcare, and technical furniture and related systems through Domestic and International operating segments.
Financial Results and Key Metrics
| Metric | Three Months Ended Jan. 31, 2018 | Three Months Ended Jan. 31, 2017 | Nine Months Ended Jan. 31, 2018 | Nine Months Ended Jan. 31, 2017 |
|---|---|---|---|---|
| Net sales | $38.2 million | $30.4 million | $113.5 million | $104.0 million |
| Gross profit | $8.4 million | $5.0 million | $23.1 million | $19.3 million |
| Gross margin | 21.9% | 16.6% | 14.4% | 13.9% |
| Operating earnings | $2.4 million | $0.4 million | $6.7 million | $4.8 million |
| Net earnings attributable to Kewaunee | $0.9 million | $0.3 million | $3.8 million | $3.1 million |
| Diluted earnings per share | $0.31 | $0.13 | $1.35 | $1.15 |
- Third-quarter sales increased 25.7%; Domestic sales rose 17.5% and International sales rose 67.2%.
- Nine-month sales increased 9.2%; Domestic sales declined to $80.4 million from $83.2 million, while International sales increased to $33.1 million from $20.8 million, primarily due to a large Middle East order.
- Operating expenses increased to $6.0 million in the quarter and $16.4 million for the nine months, representing 15.6% and 14.4% of sales, respectively.
- Income tax expense was $1.6 million for the quarter and $3.1 million for the nine months. Effective tax rates were 63.0% and 44.8%, respectively, including provisional impacts from the 2017 Tax Cuts and Jobs Act.
- Cash used in operating activities was $0.6 million for the nine months, compared with $5.9 million of cash provided in the prior-year period. Capital expenditures were $1.9 million.
- Cash and cash equivalents were $9.2 million at January 31, 2018, compared with $12.5 million at April 30, 2017.
- Working capital was $36.2 million, with a current ratio of 2.4-to-1.0.
- Total bank borrowings and interest-rate swaps were $7.5 million, including $4.5 million outstanding under the revolving credit facility. Availability under the $20 million facility was $11.3 million, and standby letters of credit totaled $4.2 million.
- Stockholders’ equity attributable to Kewaunee was $45.7 million at January 31, 2018. The company paid $1.3 million in common-stock dividends during the nine months.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially in the third quarter, driven by higher volume, operating leverage, and a more favorable product mix.
- Nine-month gross margin improved modestly due to cost-reduction and productivity initiatives and product mix.
- Operating cash flow deteriorated because of increases in receivables and inventories and a $3.8 million decline in deferred revenue.
- The order backlog reached $116.1 million at January 31, 2018, compared with $113.5 million at April 30, 2017 and $106.9 million at January 31, 2017.
- The Tax Cuts and Jobs Act produced provisional discrete tax expenses of $0.6 million from deferred-tax remeasurement and $0.5 million from the transition tax on foreign earnings. The company intends to pay the transition tax over eight years.
- Defined-benefit pension contributions totaled $0.6 million for the nine months; no additional contributions were expected for the remainder of the fiscal year.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management remained optimistic that fiscal 2018 would produce sales and earnings growth, citing strong backlog and market opportunities.
- A December 7, 2017 criminal network cyber-attack disrupted domestic manufacturing, engineering, administration, and sales operations. Operations were restored by December 12, and management stated that the impact on the reported period and the remainder of the fiscal year was expected to be immaterial.
- The cyber-attack resulted in an identified material weakness in logical access controls over information technology systems. Management expected remediation by April 30, 2018, but cautioned that completion was not assured.
- A separate material weakness related to the application of multi-element and percentage-of-completion revenue recognition policies remained unremediated. Management expected remediation by April 30, 2018.
- Disclosure controls and procedures were determined to be ineffective as of January 31, 2018.
- Key business risks include uncertain customer demand and project timing, firm-price contracts, raw-material and labor cost inflation, international operations and foreign-currency exposure, cybersecurity incidents, and general economic and competitive conditions.
- Interim results are not necessarily indicative of full-year results. The company’s accounting for certain Tax Cuts and Jobs Act provisions remained provisional, and it had not yet selected an accounting policy for GILTI effects.
Important Facts for Investors to Verify
- Confirm the timing and effectiveness of remediation for both identified material weaknesses, including revenue recognition controls and IT logical access controls.
- Monitor operating cash conversion, inventory and receivables growth, and the continued decline in deferred revenue.
- Assess whether the $116.1 million backlog converts into revenue and earnings at expected margins.
- Review the final tax effects of the Tax Cuts and Jobs Act, including deferred-tax remeasurement, transition-tax payments, and GILTI treatment.
- Evaluate liquidity under the revolving facility after considering $4.2 million of standby letters of credit and ongoing dividends and capital expenditures.
- Track cybersecurity remediation costs, insurance recoveries, possible business interruption losses, and any continuing operational effects.